Small Business Reorganization Act: Streamlined Chapter 11 Relief For Businesses and Individuals

by Nancy B. King

Chapter 11 has never been an ideal fit for small businesses and individuals. The Chapter 11 process has traditionally been too complex, lengthy, and expensive to provide meaningful relief. Congress sought to change that with the Small Business Reorganization Act that went into effect on February 19, 2020.


The SBRA streamlines the process, making it less expensive, quicker, and implementing important changes to make Chapter 11 work better for small businesses. From the beginning, however, the SBRA was criticized for the low debt limits (business debtors with secured and unsecured debts less than $2,725,625) not matching reality of the debt amounts small businesses actually carry.


Despite the limitations on debt, for debtors that meet the low debt limits, the SBRA provides meaningful changes that will benefit many small businesses and their owners. The following is a summary of the key provisions:


Qualifying as a Small Business Debtor

To file under the SBRA, a small business debtor (“SBD”) must be a person or entity engaged in commercial or business activity with aggregate secured and unsecured debt of $2,725,625. (NOTE: On March 27, 2020 Congress passed the CARES Act in response to the COVID-19 pandemic. Included in that package was a provision raising the debt limits for the SBRA from $2,725,625 to $7,500,000 FOR ONE YEAR. The legislation sunsets the debt limit for SBRA back to $2,725,625 after one year. For more information on what is included in the CARES Act that is helpful to businesses, please click here.) A SBD does not include a “single asset real estate” debtor, a defined term in the Bankruptcy Code, and does NOT require that the debtor remain engaged in the commercial or business activity post-petition. However, the SBD must show that at least 50% of the pre-petition debt is attributable to commercial or business activities. This is a voluntary election, and a SBD may choose to file a “regular” Chapter 11, a BAPCA “small business 11” or under the SBRA.

SBRA Trustee

The Act provides for electing a Subchapter V Trustee. The role of the Trustee is similar to those duties performed in Chapters 12 and 13. Specific statutory duties of the Trustee include:

· Being accountable for all property received;

· Examining proofs of claim, and objecting to proofs of claim where a purpose would be served;

· Opposing discharge where advisable;

· Providing information about the Debtor’s estate when requested by a party-in-interest;

· Creating and filing a final report and account of the administration of the estate;

· Investigating the acts, conduct, assets, liabilities, financial condition of the SBD, the operations of the SBD, the desirability of the continuance of business, and any other matter relevant to the case or formulation of the plan;

· Recommending conversion or dismissal of the case where appropriate;

· After confirmation, filing reports as are necessary or ordered by the Court;

· Ensuring that the SBD commences making timely payments required by a confirmed plan (same as chapter 12 and chapter 13 Trustees);

· Appearing and being heard at the “status conference” and on matters concerning (a) the value of property subject to a lien, (b) confirmation, (c) modification of a plan after confirmation or (d) sale of property of the estate (Chapter 12 Trustee has the same responsibilities, and Chapter 13 has the same, except not for sale of property of the estate);

· If the SBD is removed for fraud, incompetence, gross mismanagement or other “cause” then serving as the SBD debtor-in-possession;

· Performing the role of a Chapter 7 trustee if a domestic support obligation is filed; and

· Facilitating the development of a consensual plan.


The Subchapter V Trustee’s most important duties are to “facilitate in the development of a consensual plan of reorganization,” and to appear and be heard at the new “status conference.” The Trustee does not have a duty to investigate the financial affairs of the Debtor (as is required by chapter 7 and 13 trustees), but does have general oversight requirements as imposed by section 1106(a)(3), through 11 U.S.C. §1183(b)(2).


The Court can expand the duty and role of a Subchapter V Trustee for “cause” and the specified expansion is listed in § 1183(b)(2).


Duties of the SBD

Just as in a regular Chapter 11, the SBD operates as a debtor-in-possession, subject to removal for “cause” which includes things such as gross mismanagement, fraud or incompetence. The SBRA provides that the SBD has all the rights (other than the right to compensation under section 330) and powers to perform all functions and duties of a debtor-in-possession, except paragraphs (2)-(4) of section 1106. Subsections (3) and (4) are specifically assigned to the SBRA Trustee, and subsection 1106(a)(2) relates to the filing of statements and schedules by a Chapter 11 Trustee if the debtor-in-possession has not already done so.


Section 1187 requires that, upon election of the SBRA Trustee, the SBD must file (A) its most recent balance sheet, statement of operations, cash flow statement and Federal income tax return OR (B) a sworn statement that no such documents have not been prepared or filed.


The SBD must still comply with all specifically listed duties in 11 U.S.C. § 308 as well, which includes filing periodic financial and other reports showing: (1) the debtor’s profitability; (2) reasonable approximations of the debtor’s projected cash receipts and cash disbursements; (3) comparisons of actual case receipts and disbursements with projections in earlier reports; (4) whether the debtor is in compliance with postpetition requirements of the Bankruptcy Code and the Bankruptcy Rules and whether the debtor is timely filing tax returns and paying taxes and administrative expenses when due; and (5) how to the debtor plans to remedy if not in compliance.


The Status Conference

11 U.S.C. § 1183 makes a status conference in SBRA cases mandatory. The Status Conference must be held not later than 60 days after entry of the order for relief and the purpose is to “further the expeditious and economical resolution” of the case. The Court may extend the time to hold the status conference if it is “attributable to circumstances for which the debtor should not justly be held accountable.” At least 14 days prior to the Status Conference, the SBD must file and serve on the trustee and all parties in interest a report that details “the efforts the debtor has undertaken and will undertake to attain a consensual plan of reorganization.” As mentioned above, the Trustee is to appear and be heard at the status conference. On a side note, section 105 provides for status conferences in bankruptcy cases, but section 105(d) is not applicable to Subchapter V, and therefore the more specific provision of § 1183 applies.


Filing and Contents of the Plan

Only the SBD can file a plan and the SBD must do so not later than 90 days after the order for relief. The Court may extend the time if it is “attributable to circumstances for which the debtor should not justly be held accountable.” 11 U.S.C. § 1189. The timing requirements for small business debtors who do not elect under the SBRA are the same as prior law (plan must be filed within 300 days of filing, and confirmation within 45 days of filing the plan).

The SBRA provides no time limit for confirmation of the Plan, and there is NO DISCLOSURE STATEMENT REQUIRED (unless the Court orders otherwise).

What is required to be included in the Plan is set out in 11 U.S.C. § 1190 and provides that a plan shall include a brief history of the business operations of the debtor, a liquidation analysis, and projections with respect to the ability of the debtor to make payments under the plan. It must also provide for “submission of all or such portion of the future earnings or other future income of the debtor to the supervision and control of the trustee as is necessary for the execution of the plan.”

Modifying a Home Mortgage

An important new tool in the SBD’s tool box is the ability to modify the rights of a home mortgage creditor under certain conditions. Specifically, 11 U.S.C. § 1190 states that: “notwithstanding section 1123(b)(5) of this title, [the SBD] may modify the rights of the holder of a claim secured only by a security interest in the real property that is the principal residence of the debtor if the new value received in connection with the granting of the security interest was (A) not used primarily to acquire real property, and (B) used primarily in connection with the small business of the debtor.”

Confirmation - No Absolute Priority Rule

There are two paths to confirmation: (1) consensual and (2) nonconsensual. For consensual confirmation, the typical 1129(a) provisions apply, with the exception 11 U.S.C. § 1129(a)(15) (disposable income rule for individual Chapter 11 debtors).

For nonconsensual confirmation, Subsection (b) of § 1191 provides that cramdown provisions of §1129(b) do not apply in the SBRA, but instead the provisions of § 1191(b) govern in the event a plan is nonconsensual. Section 1191 allows confirmation of a plan even without an impaired accepting class as long as the plan “does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.”

“Fair and equitable” is defined in § 1191(c) to mean with respect to secured claims, the plan meets all the requirements of 1129(b)(2)(A)—the same cramdown standard for “regular” Chapter 11 cases.

For unsecured creditors under the SBRA, it is not a fair and equitable standard—instead it is a disposable income standard. This means that impaired, unsecured creditors (think deficiency balance creditors) can be forced to accept confirmation if the SBD meets the new disposable income standards. Bottom line: NO ABSOLUTE PRIORITY RULE in the SBRA, only the new disposable income standard. In addition, the SBD must establish “feasibility” and appropriate provisions in the event of a plan default.

The disposable income requirement is an either/or: either the plan provides for payment of all projected disposable income of the debtor to be received in the 3 year period (or up to 5 years as allowed by the Court) from when the first payment is due, or, the value of the property to be distributed under the plan in the 3-5 year period is not less than the projected disposable income of the debtor.

Section 1191(d) then defines “disposable income” for purposes of the SBRA as income “received by the debtor and that is not reasonably necessary to be expended for: (1) the maintenance or support of the debtor or a dependent of the debtor or a domestic support obligation that first becomes payable after the date of filing the petition or for payment of expenditures necessary for the continuation, preservation, or operation of the business of the debtor (almost the same as the Chapter 13 standard, but no difference between median and above-median debtors).

To confirm a SBRA Chapter 11 plan, the SBD must also show that the plan is feasible by showing that there is a “reasonable likelihood” that the SBD will be able to make plan payments. This appears to be a “more likely than not” feasibility standard. Confirmation requires the SBD to include “appropriate remedies” in the event that plan payments are not made.

Finally, and in a big change from other Chapter 11 provisions, Subchapter V plans may be confirmed under section 1191(b) with payment through the plan of section 503(b) administrative expenses or, in an involuntary case, section 502(f) gap period expenses instead of requiring full payment on the effective date.

Payments Under the Plan

Under 11 U.S.C. § 1194, the SBRA sets out how payments are to be made and distributed. Payments received by the trustee prior to confirmation are to be retained by the trustee. If a plan is confirmed, the trustee shall distribute payments in accordance with the plan, and if the plan is not confirmed, the trustee is to return the payments to the debtor after deducting for any unpaid claim allowed under section 503(b) (administrative), any adequate protection payments to a secured creditor, and any fee owing to the trustee. If payments are due under a nonconsensual confirmed plan, unless the plan or order confirming the plan provides otherwise, the trustee shall make payments to creditors under the plan. Finally, section 1194(c) provides that after notice and a hearing the Court may authorize the trustee to make adequate protection payments.

Modification of the Plan

Section 1193 provides for modification of a plan depending on the timing of the modification. Prior to confirmation, the debtor may modify the plan at any time prior to confirmation provided that the plan complies with section 1122 (classification of claims or interest) and 1123 (contents of the plan) (but 1123(a)(8) does not apply). The modified plan becomes the plan.

If a plan has been confirmed under § 1191(a) [consensual confirmation], modification after confirmation may be made before “substantial completion” but may not be modified so that it fails to meet sections 1122 (classification of claims and interest) and 1123 (contents of the plan) (but 1123(a)(8) does not apply). The modified plan becomes the plan if circumstances warrant the modification and the court, after notice and a hearing, confirms the plan as modified under section 1191(a).

If a plan has been confirmed under § 1191(b) [nonconsensual confirmation], the SBD may modify the plan at any time within the 3 years (up to 5 years as set by the court) but not if the plan as modified fails to meet the requirements of section 1191(b). The modified plan becomes the plan if circumstances warrant the modification and the court, after notice and a hearing, confirms the plan as modified under section 1191(b).

There is also a provision allowing change of votes for impaired classes when modification is proposed.

Discharge

Section 1192 is Subchapter V’s discharge provision and its applicability depends on if the SBD obtained a consensual or nonconsensual confirmation. A consensual plan for the individual or corporate SBD means section 1141(d)(1) applies, and plan confirmation discharges the debtor from any debt that arose prior to confirmation. (See 11 U.S.C. 1181(c) stating that if a plan is confirmed under § 1191(b) then § 1141(d) does not apply).

If it was obtained under § 1191(b) [SBRA cramdown, i.e. nonconsensual] then discharge does not occur until the debtor completes payments due within the first three years of the plan (up to 5 years as determined by the Court). The § 1192 discharge includes all debts listed in § 1141(d)(1)(A) and allowed administrative expenses provided for in the plan, BUT does not include any debt on which the last payment is due after the first three years of the plan (up to 5 years as determined by the Court) [similar to treatment of long-term debts in chapters 12 and 13] or 11 U.S.C. § 523(a) debts (otherwise nondischargeable debts).

Transactions with Professionals

Employment of professionals is allowed in the SBRA with a slightly more lenient disinterestedness standard. Notwithstanding the provisions of § 327(a), a person is not disqualified for employment under section 327 by a debtor solely because that person holds a claim of less than $10,000 that arose prepetition. It is unclear how this provision applies to the SBRA Trustee since he/she is already a professional employed to facilitate, and presumably make less expensive, the Chapter 11 process for the SBD.

Conclusion

The SBRA provides many new tools for small businesses and their owners needing Chapter 11 bankruptcy relief. With the eligibility debt limit increase to $7.5 million under the CARES Act, substantially more businesses, as well as individuals with complex financial situations, will be able to make use of it.

Prior to becoming a partner with EmergeLaw, PLC, Nancy King served for 25 years as a career judicial law clerk to the Honorable George C. Paine, II (retired) and the Honorable Randal S. Mashburn. She has extensive experience in all aspects of Chapter 11 cases, business bankruptcies, and the practice of law in the U.S. Bankruptcy Court for the Middle District of Tennessee.

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